Harum Energy

About a year ago, precisely in July 2015, I found a fact that when the Jakarta Composite Index (JCI) began to fall, in this case 7% for year to date (YTD), it turned out that mining stocks, especially coal, has dropped deeper, where the index of the mining sector have tumbled 26.3%, the worst than any other sector, and it aggravates the decline that has been occurred since the previous years. I was then asked myself, 'Is it possible that coal stocks will fall to the price of Rp50 per share, all of them???' (Note: Rp50 per share is the lowest possible price for any stock in Indonesia Stock Exchange).

Because even though coal prices continued to fall (and it causes coal companies to report declining profits, or even losses), but we cannot deny the fact that coal is still the first choice for power plant fuel. The decline in coal prices is only caused by an imbalance between supply and demand, where the demand for coal from China continued to fall since 2011 due to the economic slowdown in the country, while the coal supply continue to rise. Indonesia produced a total 458 million tons of coal in 2014, up significantly compared to 2011, which only 353 million tons. So later, when the price dropped to a level where the coal supply eventually match the demand, that's when the price decline will stop. You can read the further analysis in here.

But when we turn to the question above, will all the coal stocks fall to the bottom price of Rp50 per share? I can answer, no! Every coal stock will eventually reach their lowest prices, before then rising again.

And indeed, in 2016, the stock market began to rebound that when this article was written, the JCI has risen 19% YTD. While mining stocks including coal? Gained 47 percent! Several coal companies also began to buy back their own shares from the market (note that although the stocks dropped steadily in recent years, but only now the coal companies do a buyback). And most importantly, the coal prices also began to rise, where the latest benchmark of coal prices at Newcastle (Australia) was already US$ 72 per ton, up sharply from its lowest point of US$ 53 per ton at the end of 2015 ago.

After recognizing the above facts, I immediately check the financial statements of some coal companies aaaanndd.. gotcha! I found this company: Harum Energy (HRUM). Until the second quarter 2016, HRUM posted a net income of US$ 4.4 million, up significantly from the previous year's US$ 2.8 million, although the company’s revenue was still falling, thanks to a decrease in the price of diesel oil, which lower the cost of coal mine. At a price of Rp1,050 per share (my purchase price), the PBV is only 0.8 times. Although the valuation seemed not too cheap because the company’s profitability was still very low (the ROE is less than 5%), but in its heyday in 2011, HRUM once reported a ROE of more than 60%, and at the time the PBV was more than 5 times.

So the question now is, could HRUM acquire a larger net income so that its ROE increased, say to be 20 – 30%? Well, let's check. Since the company’s IPO in 2010, the management has always been managing the company in a ‘traditional’ way, where they only explore the coal mining, build the infrastructure, dig the coal, and send it to the buyer. They never do financial engineering, acquiring the companies in here and there, or taking large amounts of debt, and consequently the company do not have the burden of debt interests. HRUM is also one of coal companies with the most efficient cash costs in Indonesia, which is only US$ 30 per ton coal mined. From here we can see that when you later coal prices began to rise, the profit margin of the company will increase significantly, because the cost of coal production both in terms of operational and financial are equally low. And although the company deliberately lower the volume of coal production in recent years, including in this 2016 (with the aim of reducing the supply of coal on the market, which in turn raise the price), but HRUM have enough infrastructure and human resources to raise the production volume at anytime, where the company is going to do it (raise of production volume) when the price of coal is completely recovered later.

In conclusion, when later the coal prices have been stable (the company’s management prefer to use the term ‘stable prices’ rather than ‘rising price’), Harum Energy’ net income will increase significantly because of two things: An increase in profit margins, and also the increase of the value of the income itself (because of the increase in coal production/sales). All the company needs right now is a ‘stable coal price’, nothing else.

And what about the price of coal itself? In above, it is already mentioned that the benchmark price of coal in Newcastle has risen to US$ 72 per ton, but what about the future? Will the prices rise further, or instead fall once again? Well, let us look at the facts. First, in June 2016, for some reasons, the Chinese government issued regulations for local coal companies to limit their production, which raises the value of coal imports including from Indonesia. Second, the rising of coal prices is not alone, because the commodity prices are rising in general, after almost five years of falling down. Third, the supply of coal in the Asia Pacific region have dropped in the last two or three years because virtually all the coal companies were ‘agreed’ to limit their productions, which has contributed to the increase of coal prices, and it will take at least one to two years for the supply to be normal again. Fourth, although there are environmental issues in the United States where the use of coal is reduced because it causes pollution (replaced by gas), but HRUM only sells coal to Asia, in this case India, Malaysia, Taiwan, South Korea, and Japan, and there are no similar issues in these countries. And fifth, earlier HRUM, like most of other coal mining companies in Indonesia, almost export their entire coal production because of the absence of buyers in the country. But now the government is aggressively building power plants with total capacity of 35,000 Megawatt, of which 45% of them will use coal. If the construction is complete on time, the demand for coal in the country will rise sharply, so the price will be more ‘stable’.

In conclusion, although we certainly can not predict the exact price of coal in the future, but unless there are extraordinary events, no way it will fall back to a level of US$ 50’s per ton. Meanwhile, if the price rally since the last few months continues, then HRUM’ net income will certainly rise significantly by the end of the year, and likewise in 2017. While the stock price? Well, do you think???

However, in value investing, it will always be more secure if we first make sure that the company is already reporting a huge net income in its book, and only then we buy the stock. But since the stock itself has gained a lot even when the company has a less convincing financial performance (from its lowest position of Rp600 per share, it means that the stock has gained more than 70%), just like the other coal stocks that also rising, then maybe we should bold enough to buy the stock ‘ahead of schedule’, although of course by using careful analysis. And, as already discussed above, HRUM is much more likely to post a large net income rather than lose money again as 2015 ago. So this is what I call fair bet, where the chance of gains from the stock that we buy is higher (or much higher) than the risk of losses. Anyway whether you join the train or not, it is your call.

PT Harum Energy, Tbk

Rating of Performance as of Q2 2016: BBB

Rating of Stock at 1,080: A

Disclosure: When this article was written, the auther is in a position of HRUM at an average purchase price of Rp1,050 per share. This position can change at anytime without prior notice.